The Dangers of Living Large

The US Census Bureau just released its income statistics for 2008, and it's no surprise that incomes are down. But what's interesting is that during this recession, "the rich" have taken some of the biggest hits. Many who were on easy street are now struggling to get by, and this crisis has exposed the dangers of living large.

Expanding Lifestyles. When it comes to our incomes, we tend to act like goldfish, meaning we expand our lifestyles to fit our earnings capacity. If we make more, we spend more. While it's great to have a big salary, if you live too large, your lifestyle will undercut the security that comes from that big income. Here's why:

Limited Opportunities. Let's assume you have a salary that puts you somewhere in the top one to five percent of wage earners, which goes from about $200,000 to $400,000 (and up) in pay. That's great. But it also means that 95 to 99 percent of the jobs out there pay less than what you currently make.

If you lose your job, it's going to be tough to replace that income because by definition there just aren't that many business opportunities that pay that high a wage.
Now, we all like to think that good fortune doesn't have much to do with our pay; we believe we're being paid solely for our skills.
But the reality is that if you're a high wage earner, there's generally some degree of good fortune in that salary. Maybe you work for a company that has had exceptional growth, or you worked in a sector of the economy that was hot for a decade, or just maybe the global economy favored what you were doing.
Some of the factors that created the environment for a high salary are outside of your control, and if they change, you may not be able to reproduce them. So it's prudent to consider that part of your pay is the result of good fortune, and accept that it might not always be there.

Bonus. Moreover, many high paying jobs have a base salary and a bonus. And the bonus can often constitute anywhere from 25 to 50 percent of your pay.

Bonuses, however, tend to shrink during recessions because bonus formulas are often based on profits or new business opportunities that also tend to shrink during recessions.
So even if you don't lose your job, you can easily see your income fall significanlty during a recession.

70 Percent. If you have a high salary, a good rule of thumb is to consider living on not more than 70 percent of what you make. That way if you lose your job, you don't have to find one that replaces 100 percent of what you were earning, which gives you far more options. Or, if your income falls because of lower bonuses, you can still maintain the same standard of living. The nice thing is you have the luxury to do this, because even at 70 percent, you're still living pretty large.

But if you ramp up your lifestyle to fit that big salary, you may find that your financial life could quickly unravel. It's bad enough if you lose your job, but it's even worse if you're forced to try to sell your big house (or big second house) in a bad economy and have to pull the kids out of private school.

Bottom line. A big salary can create a lot of financial security and a nice lifestyle. But if you don't recognize that a portion of that high salary is vulnerable to factors outside of your control, living large can undermine your financial future.

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